E-Book Overview
This paper analyses the joint provision of e¡ort by an entrepreneur and by an advisor to improve the productivity of an investment project.Without moral hazard, it is optimal that both exert e¡ort.With moral hazard, if the entrepreneur's e¡ort is more e⁄cient (less costly) than the advisor's e¡ort, the latter is not hired if she does not provide funds. Outside ¢nancing arises endogenously. This explains why investors like venture capitalists are value enhancing.The level of outside ¢nancing determines whether common stocks or convertible bonds should be issued in response to incentives.
E-Book Content
THE JOURNAL OF FINANCE VOL. LVIII, NO. 5 OCTOBER 2003
Financing and Advising: Optimal Financial Contracts with Venture Capitalists CATHERINE CASAMATTA n ABSTRACT This paper analyses the joint provision of e¡ort by an entrepreneur and by an advisor to improve the productivity of an investment project. Without moral hazard, it is optimal that both exert e¡ort.With moral hazard, if the entrepreneur’s e¡ort is more e⁄cient (less costly) than the advisor’s e¡ort, the latter is not hired if she does not provide funds. Outside ¢nancing arises endogenously. This explains why investors like venture capitalists are value enhancing. The level of outside ¢nancing determines whether common stocks or convertible bonds should be issued in response to incentives.
THE VENTURE CAPITAL INDUSTRY has grown dramatically over the last decade. In the United States, venture capital (hereafter VC) investments grew from $3.3 billion in 1990 to $100 billion in 2000. In Europe, funds invested in VC grew from $6.4 billion in 1998 to more than $10 billion in 1999. The success of VC is largely due to the active involvement of the venture capitalists. These so-called hands-on investors carefully select the investment projects they are proposed (Sahlman